By Webber Wentzel – South Africa
Section 23N, which replaced section 23K with effect from 1 April 2014, prescribes rules to cap the deduction of interest incurred in respect of debt incurred by the acquirer of a business pursuant to a section 45 intra-group transfer, a section 47 liquidation distribution or a section 24O acquisition of shares. Section 23N applies to the refinancing of debt that was subject to section 23K and/or section 23N.
Currently, the acquisition debt interest incurred by the acquiring company must, in any year of assessment in which the transaction is entered into, and for a period of five years of assessment thereafter, not exceed the sum of the amount of interest received by or accrued to the acquiring company, plus 40% of the higher of the “adjusted taxable income” incurred in the first year in which the acquisition occurred or the year being tested.
The Draft Taxation Laws Amendment Bill, 2014 (DTLAB) proposes that “adjusted taxable income”, which is calculated with “taxable income” as the starting point, must be adjusted to add back any assessed losses which are included in the calculation of “taxable income”. The effect thereof is that “adjusted taxable income” will more closely equal the EBITDA of the transferee which acquires the assets and not prejudice the tax deductibility of interest incurred by a company which has an assessed loss available for carry forward from a prior year.
Section 23N currently provides for an indexing of the allowable percentage (currently 40%) to the extent that South Africa’s average repo rate increases beyond 10%. This means that come 1 April 2014, the repo rate will need to increase by more than 5%, before the allowable cap is increased. It is proposed that this ratio be amended so that the acquisition debt interest incurred by the acquiring company must not exceed the sum of the amount of interest received by or accrued to the acquiring company, plus the company’s “adjusted taxable income” multiplied by the sum of the average repo rate plus 400 basis points divided by 10 multiplied by 40 (as a percentage). The ratio of “adjusted taxable income” which may be claimed as a deduction may not exceed 60% of “adjusted taxable income”.
The implication of the proposed DTLAB amendments to the indexation of the proportion of interest which will be deductible is that at the current repo rate of 5.75%, only 39% of “adjusted taxable income” will be deductible, but that this percentage may increase to 60% to the extent that the average repo rate increases to 11%. Thereafter, a greater proportion of the interest claimed by the acquiring company will not be deductible to the extent that the average repo rate continues to increase beyond 11%.
The proposed amendments come into operation on 1 January 2015 and apply in respect of years of assessment commencing on or after that date. The amendments are not retrospective, preventing a company which entered into an acquisition transaction before this date from receiving the benefit of being able to add back assessed losses in the calculation of its “adjusted taxable income” for its years of assessment commencing before 1 January 2015.
No amendments have been proposed by National Treasury to allow for the carry forward of losses which are not deductible in a particular year as a result of the deductible interest limitations being triggered.
The proposed changes to section 23N are welcomed and in addition we hope to see the enactment of legislation which permits the carry forward of disallowed interest and the proposed amendments applied with retrospective effect once this legislation is introduced in its final form.